An Introduction to Carbon Offsets

Carbon offsets are tradable rights or certificates allowing a person or an entity to fund projects that fight climate change instead of taking direct action to lower their own carbon emissions.

In order to mitigate the climate crisis, countries across the globe have made ambitious commitments with the intent to reduce greenhouse gas (GHG) emissions.

What are Carbon Offsets?

Carbon offsets are tradable “rights” or certificates linked to activities that lower the amount of carbon dioxide in the atmosphere. A carbon offset represents a removal of GHG emissions of carbon dioxide or other greenhouse gases made in order to compensate for emissions made elsewhere. So, any activity that absorbs a tonne of CO2 from the atmosphere in one part of the world would cancel the effect of a tonne of gas emitted in another. When an entity is unable to avoid, reduce, or remove emissions from its own value chain, it funds activities elsewhere to remove emissions from the atmosphere in their stead.

Carbon Offsets vs Carbon Credits – is there a difference?

The terms Carbon Offsets and Carbon Credits are often used interchangeably despite the two instruments serving different purposes. For every tonne of CO2 that an activity manages to absorb, avoid or otherwise reduce, a carbon credit can be issued. A carbon credit is a tradeable permit that allows a polluting company to emit one tonne of CO2 and can sold or purchased depending on the volume of CO2 the company emits. A carbon credit may be created by the government or awarded when the equivalent of one tonne of carbon dioxide (CO2 -e) is removed from the atmosphere and stored in the land or is prevented from being released into the atmosphere. Both, carbon offsets and carbon credits are instruments sold in the carbon market. Further, there are two kinds of carbon markets, compliance markets and voluntary markets.

How do carbon Offsets work - Compliance Market

How do carbon offsets work - voluntary market
Figure 1: Compliance and Voluntary Carbon Market

How do Carbon Offsets work?

In the past two decades, markets for the exchange of carbon offsets have evolved and developed processes that facilitate orderly exchange. The voluntary carbon offset market is regulated by non-governmental actors and a handful of registries.  The process of generating a carbon offset begins with the production of an ERR or Emission Reduction or Removal. Once an ERR has been generated and certified under a reputable standard, it can be issued as a tradable unit called a “carbon credit”.

Figure 2: Life cycle of a carbon credit

When a carbon credit is used to compensate for emissions elsewhere, it is “retired”, i.e., taken out of circulation and can no longer be sold; at this point, a carbon credit becomes a carbon offset. ERR and subsequent generation of a carbon offset can be done in a number of ways – preventing deforestation, preserving forests, planting trees, distributing fuel-efficient cookstoves, changing agricultural practices, and capturing and destroying landfill gas are a few of the many examples. To ensure the credibility of the offset and whether emission reductions or removal are real, carbon offsetting projects need to be validated and verified by an internationally verified standard.

Offsetting projects must satisfy the robust criteria set by standardisation bodies. The following image briefly describes the criteria for a project to be certified and generate carbon credits:

Figure 3: Criteria for a Project to Generate Carbon Credits

Additionally, appropriate safeguards must be put in place to ensure projects comprehensively address and mitigate all potential environmental and social risks.

Emission reduction projects operate in 8 major sectors wherein projects earn certified emission reduction (CER) credits, each equivalent to one metric ton of CO2. These sectors are – Forestry and Land Use, Renewable Energy, Chemical Process/Industrial Manufacturing, Household/Community Devices, Waste Disposal, Energy Efficiency/ Fuel Switching, Agriculture, and Transportation.

Figure 4: Sector-wise estimated retirement price of carbon credits (in $) Source: Allied Offsets (February 2023)

What is the scope for voluntary carbon markets?

It is estimated that while Europe and China will be able to reduce local emissions marginally, the net global emissions will see a rise. Reduction and removal of emissions are critical to ensure a healthy planet for future generations. Carbon offsets carry immense potential to help advance the journey towards net neutral in the coming years.  In this regard, voluntary carbon markets have held their place as a critical lever to realise climate goals. With carbon emissions rising, the growth of the markets has been driven by increasing corporate efforts to offset their carbon footprints. As stakeholders and consumers begin to hold corporates accountable to take climate action, more companies are setting net-zero targets, leading to increasing demand for climate solutions – one of which is provided by the voluntary carbon market.



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